Question

The following table shows the bushels of corn and kgs of beef that Mainland and Wishland can produce per day.
Corn Beef Mainland 12 Corn 16 Beef Wishland 4 corn 8 beef
(a) Identify the commodity in which Mainland and Wishland have absolute advantage in and absolute disadvantage in. Identify the commodity in which Mainland and Wishland have comparative advantage in and comparative disadvantage in.

(b) Indicate whether or not trade is possible and the basis for trade if possible. What is the range for the terms of trade for mutually benecial trade if possible? i. Would it be good for Mainland to exchange 3 bushels of corn for 3 kgs of beef with Wishland and would Wishland agree? ii. Would it be good for Mainland to exchange 4 bushels of corn for 7 kgs of beef with Wishland and would Wishland agree? iii. Would it be good for Mainland to exchange 3 bushels of corn for 7 kgs of beef with Wishland and would Wishland agree?

Answer 1

A) Mainland has absolute advantage in production of both corn and beef because it can produce more of both goods in one day, than wishland does. So, Wishland has absolute disadvantage in production of both goods because it's productivity is less than Mainland's.

For mainland, opportunity cost of producing 1 beef is (12/16) = (3/4) corn and opportunity cost of producing 1 corn is (16/12) = (4/3) beef.

For Wishland, opportunity cost of producing 1 beef is (4/8) = (1/2) corn and opportunity cost of producing 1 corn is (8/4) = 2 beefs.

As, Mainland's opportunity cost of producing 1 corn is less than that of Wishland's , it means Mainland has comparative advantage in corn production and comparative disadvantage in beef production. On the other hand, Wishland has comparative advantage in beef production, because opportunity cost of producing 1 beef for Wishland is less than that of Mainland's. And, wishland therefore has comparative disadvantage in production of corn.

B) These two countries can trade with each other if they specialize in the production in which they have comparative advantage. Price of trade(price of corn in terms of beef) should lie between both countries' opportunity cost of producing corn. That is, if the price of trade is between (4/3) beefs and 2 beefs for each unit corn that is exchanged, then both countries will be benefitted from trade.

From the given options, it would only be beneficial for both countries if Mainland exchange 4 bushels of corn for 7 kgs of beef with wishland. Wishland will also agree because here price of trade is (7/4) = 1.75 beefs for each unit of corn traded, and this price lies between (4/3) beefs and 2 beefs.